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RBI set to hike rates to curb inflation
Published on 24 Jan. 2011 11:28 PM IST
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Trying to push up the price of a commodity while increasing its supply might sound an economic impossibility, but that is exactly what the central bank is likely to attempt when it reviews its monetary policy on Tuesday.
Bankers, bond dealers and economists are almost unanimous that a rate hike is likely on January 25. Given the increase in prices, the central bank has to be seen to be doing something to rein in inflation-and when it comes to inflation the only weapon in RBI’s armoury is interest rates. “We expect a 25-basis point increase in interest rates,” said O P Bhatt, chairman, State Bank of India, stating a view that is echoed by most other bank chairmen.
“The market has widely factored in a 25-bps increase by the RBI. Indeed, the spike in December 2010 wholesale price index inflation to 8.43% and the sharp upward revision of October inflation to 9.12% leave the RBI with little choice but to hike,” said Standard Chartered Bank in a report. But there are equally sound reasons for the central bank to increase the supply of funds to the banking sector. The RBI, which is supposed to be the lender of the last resort, is lending around Rs.1,00,000 crore to banks daily as a matter of course. The central bank had earlier indicated that a deficit of funds in the banking systems helps it better in controlling prices.
However, it also said that a deficit of more than one per cent of bank deposits would be outside its comfort zone. Given that bank deposits are less than Rs.50,000 lakh crore, the current deficit is more than double of RBI’s comfort zone limit. SBI, the country’s largest bank, has been regularly borrowing from the central bank and most banks are unable to raise enough deposits to meet their lending obligations.
Money market dealers expect that there will be some measures to ease liquidity. However, there is no consensus on what these measures will be. Some expect that the RBI will ease reserve requirements of cash reserve ratio (CRR) and statutory liquidity ratio (SLR). The CRR and SLR refer to the portion of deposits that have to be compulsorily maintained in cash deposits with the RBI and in government bonds respectively. Others expect that the central bank may decide to make more money available to banks by offering to buy bonds from banks that are short of funds.
The RBI needs to keep the liquidity tap flowing also because growth is no longer at the pace it used to be. According to Bhatt, the country’s largest bank may not be able to sustain a 20% growth in credit until the end of the financial year. “The surge in credit, which was witnessed in the third quarter, last year, did not happen this year. Also part of the reason for the strong credit growth in the third quarter was strong demand from oil companies because of the increase in oil prices,” Bhatt added. He said the RBI will have to balance growth and inflation interests in its monetary policy.
According to Standard Chartered, the RBI will have to extend tactical measures to ease liquidity. This is because the banking system is coming under strain as a large amount of money is being held in currency form and it is uncertain whether the government will release some cash from its surplus through spending.

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